Skip to main content

RE27RC26: 1031 Tax Deferred Exchanges

See below for a description of Tax Deferred Exchanges.
Skip table of contents
You skipped the table of contents section.

Objectives

Familiarize the real estate licensee with the concept of capital gain tax deferment, the terminology associated with the 1031 exchange, and the key aspect of the exchange which may impact a real estate transaction

  1. Fundamentals of a 1031 exchange
    1. History of tax deferred exchange §1031 Internal Revenue Code
      1. The Revenue Act of 1918 and 1921
      2. The Revenue Act of 1924: eliminated non like-kind exchanges.
      3. 1970's Starker Exchange: beginning of delayed exchange
      4. The Revenue Reconciliation Act of 1989 - only within the United States
      5. The tax Cuts and Jobs Act of 2017 – limited to real estate
    2. What is a 1031 Exchange
      1. INTERNAL REVENUE CODE SECTION 1031
        1. Investors can potentially defer 100% of their capital gain taxes, both state and federal
        2. Emphasis placed on "deferred" not "free"
        3. However, upon a subsequent sale of property, the capital gain is deferred will be recognized unless another exchange is completed.
        4. Section 1031 equals an interest-free, no-term loan from the IRS on the taxes due

      2. Provides safe and legal procedure for rolling sales profits into new property as a non-taxable event.

        “No gain or loss shall be recognized on the exchange of property held for productive use in a trade or business or for investment if such property is exchanged solely for property of like-kind which is to be held either for productive use in a trade or business or for investment.”

      3. It is not a "swap", but a deferment of a capital gain tax obligation in exchange of staying invested in real estate
      4. Applies to business use and investment properties
      5. Includes rental, land, residential, industrial and commercial real estate
  2. Properties qualifying
    1. Relinquished property: property (ies) being sold by the exchanger: property held for productive use in a trade or business or for investment
    2. Replacement property: property (ies) being bought by the exchanger
      1. property intended to be held for productive use in a trade or business or for investment
      2. Like-kind exchange: Section 1031 exchanges limited to property within the United States "As used in IRC 1031(a), the words LIKE-KIND have reference to the nature or character of the property and not to its grade or quality. One kind or class of property may not, under that section, be exchanged for property of a different kind or class. The fact that any real estate involved is improved or unimproved is not material, for that fact relates only to the grade or quality of the property and not to its kind or class. Unproductive real estate held by one other than a dealer for future use or future realization of the increment in value is held for investment and not primarily for sale."
      3. Holding period after closing is important, no definite minimum, intent is the critical issue
        1. (1) Section 1031 exchanges between related parties - (2) year rule
        2. (2) Section 1031 and Section 121 combined - (5) year holding period
      4. Vacation/second homes must generate income, limit on personal use (greater of 14 days or 10% of the time rented)
      5. Cannot use a 1031 exchange when “flipping” properties (Buyer/fix/sell), must hold for investment to qualify

    3. Principal residence

      TAXPAYER RELIEF ACT OF 1997 - IRC SECTION 121 - PRINCIPAL RESIDENCE

      (Which house is the "principal" residence?)

      1. Generally, the property the taxpayer uses in excess of six months per year will be considered the taxpayer's principal residence (benefits from the capital gain exemption amount of $500K if married, $250K if single)
      2. Many factors are relevant in determining which home is the "principal residence" of taxpayers who own more than one home. Amongst them are:
        1. place of employment
        2. amount of time property is occupied
        3. where other family members live
        4. address used for tax returns
        5. driver's license, car and voter registration
        6. bills and correspondence and location of taxpayer's banks and clubs
        7. primary banking depositories
  3. Process
    1. Exchanger: Owner of the property being sold and buyer of the property being purchased Same entity must sell and buy
    2. Qualified Intermediary (QI): independent third party monitoring the exchange
      1. Required entity that facilitates the exchange
      2. Cannot be a related party, e.g., agent, attorney, broker
      3. Holds funds/title until all the transactions are complete
        1. all monies to flow through intermediary until confirmation that the transactions meet the IRS requirements for the deferment
        2. receives the relinquished property from the Exchanger and sells to the buyer.
        3. purchases the replacement property from the seller and transfers it to the Exchanger.
        4. Exchanger has no access to funds during the exchange
      4. Functions as IRS monitor
      5. Responsible for the identification list
      6. Paid a fee
    3. Identification period and rules
      1. 45 calendar days, no extensions
      2. In writing
      3. Identification rules
        1. Three Property Rule: The Exchanger may identify a maximum of three (3) replacement properties without regard to the fair market value of the properties.
        2. 200% Rule: The Exchanger may identify any number of properties so long as the aggregate fair market value does not exceed 200% of the relinquished properties.
        3. 95% Rule: The Exchanger may identify any number of properties without regard to the aggregate fair market value so long as Exchanger receives 95% of the aggregate fair market value of all identified replacement prior to the end of 180--day period.
    4. Total exchange period
      1. 180 calendar days or day tax return is due (whichever is sooner)
      2. No extensions available
      3. Includes the 45 day identification period
      4. Delayed exchange:
        1. Sale of relinquished property – all funds go to QI
        2. Identification no later than 45 calendar days after closing
        3. Closing on replacement property within 180 days of first sale
        4. Exchange equation: rules for full deferral
          1. 100% proceeds
          2. Equal or greater debt
      5. Reverse exchange
        1. Replacement property is bought first (requires additional funds)
        2. Identification is of property(ies) to be sold
        3. All sales of relinquished property(ies) to be concluded within 180 days
      6. Improvement Exchange: The improvement (also called a construction or build to suit) exchange allows an Exchanger, through the use of a Qualified Intermediary and Exchange Accommodation Titleholder (ET), to make improvements on a replacement property using exchange equity
      7. Boot: additional funds part of the exchange, "Non like-kind' property, taxable to the extent there is capital gain
        1. Cash boot would be cash not re-invested in replacement property, subject to capital gain tax
        2. Mortgage boot is the difference in financed amount
  4. Choosing a qualified intermediary (QI)
    1. The role of the QI is critical – hold funds and responsible to confirm to the IRS that the transactions meet the tax code, and tax qualifies to be deferred
    2. The QI can be an individual attorney/accountant or a QI company, but cannot be related to exchanger
    3. Not a regulated industry
      1. Some are members of the Federation of Exchange Accommodators
      2. Safety of funds is critical – they hold all funds through the process
Last updated: March 13, 2026

Help Us Improve Mass.gov  with your feedback

Please do not include personal or contact information.
Feedback